Focus on Airport Economics

by John F. Infanger On Jul 13, 2007

PHOENIX — Each spring, the people who manage the purse strings at North American airports meet for the Airport Economics & Finance Conference, hosted by Airports Council International-North America. Also participating are related consulting firms and airline representatives. Among the hot topics at this year’s meeting held here: the recent rates and charges dispute at LAX; escalating construction costs; airline/airport terminal agreements; employee screening; and privatization. Following are highlights from this year’s conference.

The meeting kicked off with a discussion about the state of the North American economy in general. Dr. Mike W. Tretheway, executive VP and chief economist for the consulting firm InterVISTAS, reports that 2007 has seen a “soft landing” after the high growth years between 2003-2006 in the U.S. Tretheway says that he expects fuel prices to stabilize around current levels; however, he projects that long-term per-barrel oil prices could drop as China and India incorporate more efficient ways to operate their industries.

In Canada, the Western provinces are in a high-growth mode, led by oil exploration in Alberta. (Tretheway says Alberta is expected to surpass Saudi Arabia as the world’s major oil exporter by 2015.) In Mexico, he cautions, rising prices for corn could have a destabilizing effect on the overall economy, which in general terms typically tracks with the U.S.

Regarding airline economics, Robert A. Hazel, a managing partner with Eclat Consulting, Inc., says that the carriers are facing weaker demand and are losing pricing power. While yields crept up in the first half of 2006, he says, they dropped off in the last half. The airline industry is at the end of a “very slim recovery,” he comments.

At the same time, Hazel says airlines are running out of ways to cut costs. “There are no easy ways to cut costs anymore,” he says. Yet, start-ups keep coming: Skybus; Virgin America; Express Jet.

An overall impact of the volatile nature of today’s airline economics, says Hazel, is reduced service to smaller commercial airports. He says that on average the smallest U.S. airports in recent years have lost 44 percent of the seats serving their markets.

The airlines’ cost-cutting exercise is leading to more demand on airports to provide amenities and maintenance services (boarding bridges, etc.), explains Hazel. As a result, airports are becoming “key differentiators” in the air travel experience, he says.

‘An unprecedented circumstance’
Among the greatest challenges facing airports today is the ongoing escalation in construction costs, addressed in depth at the conference. Frank Congelio, an economist with the Bureau of Labor Statistics, reports that from 2004 to 2006 concrete prices alone surged more than 40 percent in the U.S., while copper has seen increases of more than 25 percent in the past year. While growth in China is one reason for the jumps, he says that that nation is actually helping abate concrete price spikes because it is now exporting the product to the U.S.

Predicting where the volatile sector is headed is difficult, says Congelio, particularly due to the “interrelationship” in the construction materials market. For example: the price of asphalt can be impacted not only by demand but by decisions made by refineries on which products to produce. Also, a recent dropoff in construction demand in the residential sector has been offset by a corresponding rise in the non-residential sector.

Mike Dell’Isola, senior VP with Faithful+Gould, a consulting firm, terms the current construction situation and its impact on bids “an unprecedented circumstance.” Bids on airport projects are coming in as much as 50 percent over budget — sometimes a much as double original estimates, he says.
“Demand for construction has outstripped supply,” comments Dell’Isola.

Of particular concern, he says, is a lack of subcontractors who are in high demand. That has led to a bidding environment in which many projects today are only receiving one or two bids on requests for proposals, which means less competition on pricing and schedules. “The lack of competition is a big factor in what’s going on,” he explains.

Dell’Isola says that for buyers the market has tightened even more in the past six months, and he expects the demand on construction resources to continue through at least 2011. Bids going out within the next 12 months can expect to pay premiums as high as 20 percent over current projections, he says.

He recommends that planners be selective in their material choices, and consider “creative approaches” such as flexible delivery times or separating out various phases of a large project to maintain a realistic handle on cost and schedule.

James Gill, CFO at Raleigh-Durham International Airport, reports that his terminal reconstruction project increased from the original cost estimate of $350 million in 2003 by another $80 million in 2005. He attributes $10 million of that hike to the tight bidding environment.

His list of considerations for other airports includes:

create a partnership among planning, construction, and finance staffs at the airport;

phase or modularize major projects, if possible;

manage risks that can be controlled — for example, locking in low interest rates; and

scrutinize contractors’ backgrounds, looking for a history of work order changes.

Lax rates & charges
Attorney Scott Lewis, a partner with the D.C. firm Anderson Kreiger LLP, has been serving as legal counsel for ACI-NA in its efforts to support Los Angeles International Airport in its recent rates and charges dispute with several tenant airlines.

In essence, LAX is attempting to transition from a traditional residual agreement with carriers to a more compensatory one, a trend at U.S. airports for some time.

LAX has a mix of terminal agreements, several of which are 40-year lease agreements with legacy carriers made in the 1980s, according to Lewis. Basically, says Lewis, the ensuing lawsuit by various carriers came as a result of the city’s decision to change the methodology on how it charged non-signatory carriers in several of its terminals. “There was no agreement with those carriers,” he says.

As a result, the affected domestic carriers and international carriers sued. Those supporting LAX included ACI-NA; the Air Transport Assocation; and the legacy carriers, says Lewis.

An administrative law judge struck down the LAX position, referring it to U.S. DOT for a final decision, reached in mid-June. [See Industry News.] Some of the more important aspects of the decision, according to Lewis, were that the judge did not have an issue with the compensatory model of charging carriers, and that airlines have no “right” to share in non-aeronautical revenues.

“Airports clearly have an obligation to consult with airlines,” says Lewis, but has no duty to enter into an agreement. While the city of Los Angeles was attempting to more readily cover its costs, a rate change without a presumptive change in costs are ruled unreasonable, he explains.

A particular concern, says Lewis, is raised at an airport the size of LAX, where there are numerous terminals with varying leases — from 40-year agreements to short-term to none at all. The administrative law judge, he says, essentially ruled that there should be no difference in the agreements. In this case, Lewis points out, none of the parties proposed what a “reasonable differential” should look like in a situation that is the scope of an LAX.

In a 1996 rates and charges case involving LAX, the U.S. DOT made a distinction between aeronautical and non-aeronautical revenues, and on airfield versus non-airfield facilities. In this case, the airlines argued that the city cannot use fair market value on terminal facilities as it can for airfield facilities.

LAX, with ACI-NA’s backing, took the position that those rules could and should be different, says Lewis.

One caution for other airports, says Lewis, is the fact that the administrative law judge had issues with LAX calculations, and the airport was forced to redo them three times, making the authority’s numbers “suspect.”

MDW and privatization
Meanwhile, the decision last fall by the City of Chicago to apply to have Midway Airport enter into FAA’s Privatization Pilot Program (PPP) has put the issue back on the U.S. airport industry’s radar screen. A popular concept worldwide, privatization has its skeptics in the U.S. — many see it as a way to divert airport revenues into city coffers.

Susan Gray, a director at Macquarie Bank, an active player in privatization in other countries, calls privatization a “transfer of risk” and that typically a private firm like Macquarie leaves policies and personnel in place. Privatization can be particularly attractive, she says, for an airport that has capital needs that it cannot address on its own.

David Narefsky, an attorney with Mayer, Brown Rowe & Maw, is part of the Chicago team involved with the Midway initiative. He says that since 1987 some 50 airports worldwide have undergone privatization — “it’s a very active market,” he says.

Narefsky adds, “We recognize that this will only work if it works for the airlines, the city, and the private operator.”